The decaying mansion at the corner of Esplanade Avenue and Bourbon street once loomed darkly over the French Quarter, a gothic relic reduced to blight.

But over four years, the neglected Whann-Bohn house and servants' quarters were painstakingly transformed into an elegantly renovated space for visiting movie editors to live and craft their films with the flavor of old New Orleans, rather than fly back to Los Angeles to finish their work. Developers hoped to capture a slice of the burgeoning local movie scene, an industry boosted by Louisiana's entertainment-friendly tax credit incentives.

In 2012, as the Seven Arts Post studios opened for business, developers told NOLA.com | The Times-Picayune that the project had cost $13 million.

But an indictment handed down by a federal grand jury last month says that 807 Esplanade Ave. was at the heart of a conspiracy between a Hollywood lawyer-producer and a New Orleans lawyer-actor to lie about expenses on the project to get $1.13 million in tax credits. The tax credits were then sold to local people and businesses for a profit.

Peter Hoffman, a Los Angeles lawyer and producer, and Michael Arata, a New Orleans lawyer and actor, are each charged with conspiracy and five counts of wire fraud. The indictment points to a web of companies associated with the two men; fake bills for construction that hadn't been performed and film equipment that wasn't purchased; and money transfers between bank accounts to keep up appearances of payments. The indictment focuses on documents submitted to state authorities and auditors in 2008 and 2009.

Both men have pleaded not guilty to the charges. Hoffman's company Seven Arts Entertainment said in a written statement that the tax credits cited in the indictment have been reviewed and certified by state officials and underwent two forensic audits, which were both accepted by the state. Hoffman said the charges are unfounded.

"While the U.S. attorney seems to assert that the building is not in use as a residential and post-production facility, it has, as previously announced, been open and operating as such since July 2012," the company said. "Several theatrical motion picture and television productions have enjoyed doing production work at the property with many more scheduled for 2014."

The rift over the legitimacy of the project, which relied on a film infrastructure tax credit program that has since ended, is set to play out in federal court. The FBI along with the Louisiana Office of the Inspector General investigated the case. The U.S. Attorney's Office in New Orleans declined to comment.

State and local leaders have praised the film tax credit program arguing that millions of dollars given away in tax dollars every year brings back millions more in jobs and contracts for local businesses. But the program has a troubled history of corruption, and budget watchdogs have called the program a costly waste in a cash-strapped state.

By design, Louisiana's film tax credits are transferable and refundable, in an effort to attract out-of-state entertainment companies that don't have Louisiana tax liabilities to worry about. The production companies can instead sell the credits to other businesses or give the credits back to the state for an 85 percent refund, as a way to raise cash.

In addition to movie and TV productions, the state also offered tax credits to film-infrastructure projects -- such as a studio -- at 40 percent of approved expenses. The infrastructure program closed to new applicants at the beginning of 2009.

The actual harm to Louisiana taxpayers in connection with the fraud case outlined in the indictments remains unclear. Louisiana Economic Development Secretary Stephen Moret, whose department administers film tax credits, said in a written statement to NOLA.com | The Times-Picayune that in the case of Seven Arts, based on the records submitted to the state, it appears that $1.1 million in tax credits are supported by actual project spending.

Seven Arts recently applied for $3 million more in tax credits, which the state denied.

"Accordingly, the state's fiscal exposure in this case appears to be minimal because the additional tax credit request has been denied," Moret said. "As was the case with Seven Arts, whenever (the Office of Entertainment Industry Development) cannot ascertain the true nature of a suspected transaction, even after multiple levels of review and a forensic examination by a certified fraud examiner, LED ... has referred our concerns to the Inspector General, which regularly engages the FBI, because those agencies have subpoena powers and can obtain third-party records."

The state Office of Entertainment Industry recently said it has identified two issues in need of improvement in the program: more oversight of Certified Public Accountants hired to audit applications and stricter policies on granting tax credits on transactions among affiliated companies.

The business partners

Michael Arata, developer of a post-production studio at 807 Esplanade Ave., walks through the un-renovated mansion in 2009.NOLA.com | The Times-Picayune

Hoffman is the former CEO and founder of Seven Arts Entertainment Inc., an independent movie company traded over the counter (OTCQB:SAPXD). He resigned Feb. 10 after the indictment was handed down in New Orleans. The company is now led by Hoffman's daughter, Kate Hoffman.

In an interview, Peter Hoffman said he believes the charges are baseless and rely on "a misunderstanding of the infrastructure tax credit system."

"The state reissued the credits under attack on Sept. 4, 2012 with full knowledge of the U.S. Attorney investigation," Hoffman said. "Seven Arts Pictures Louisiana did everything with respect to the building that it promised to do."

Hoffman has been a major player in the entertainment industry as a lawyer and president of the now-defunct Carolco Pictures, the production company behind "Terminator 2: Judgment Day" and "Total Recall." In a 2006 profile in the Los Angeles Times, Hoffman was remembered as having thrown a party "that some say still ranks as the single most extravagant and star-studded event" during the Cannes Film Festival on board a boat in the Mediterranean in 1990. But the company later spiraled into bankruptcy, and Hoffman moved on to Seven Arts.

Arata, a local stage and film actor and Tulane Law graduate, was a partner in VooDoo Productions, one of the 807 Esplanade Ave.'s original developers. He is married to Deputy New Orleans Mayor Emily Sneed Arata.

VooDoo Productions produced the locally shot horror film "Autopsy" in partnership with Seven Arts Pictures in 2008. Arata is listed as an executive producer on recent films "Odd Thomas," based on a Dean Koontz novel, and "The Courier," starring Mickey Rourke and Jeffrey Dean Morgan, among a dozen films, according to the Internet Movie Database.

He was an early advocate for the state's 2001 expansion of film tax credits and has continued to promote the program. In December, he taught a certified legal education course organized by the New Orleans Bar Association to instruct lawyers about getting and using entertainment tax credits. The other presenter in the class was a staff lawyer for the Louisiana Department of Economic Development.

The story of the Seven Arts studios goes back to 2007, when developers successfully pitched their idea to venture capital firm Advantage Capital Partners, which agreed to a $3.7 million investment, including $1.7 million to buy the house and another $2 million for renovation. The studios would cater to small and independent films, the developers said, hosting perhaps two crews at a time.

"We want to essentially trap the business and double the amount of time they spend here," Arata told The Times-Picayune in 2009. "Post-production can amount to 25 to 30 percent of a film's cost, and that has left Louisiana." That same year, the company applied for film infrastructure tax credits.

Delays and cost overruns left work on the unfinished studios at a standstill in 2010. "The company (Seven Arts) was in a position where they couldn't get it finished nor could they continue to service our debt," said Michael Johnson, Advantage Capital managing director. "They had basically run out of money."

Advantage Capital had to decide whether to invest more or foreclose on the property. Instead, Seven Arts found another investor, lender Palm Finance Corp. Advantage Capital pulled out of the venture at a loss, a company spokesman said.

The head of Palm Finance in California, Steven Markoff, declined to comment.

A federal investigation

Seven Arts Entertainment company officials were aware of the federal probe for at least two years, and in 2012 the company turned over records in response to a subpoena. The company reported that fact to investors last year in a quarterly report. "This investigation appears to include investigation as to whether certain expenses claimed by this affiliate were improper or fraudulent," the company said.

Arata owned LEAP Film Funds II LLC, which brokered and sold Louisiana film tax credits, according to the indictment.

The indictment says the business partners submitted false and misleading records of bank transfer statements, vendor payments, internal accounting and tax credit applications supporting documents to auditors, who based an audit on the records, and to state authorities. It counts more than a dozen instances in 2008 and 2009.

Another look at film credits

One week after the indictment was unsealed in U.S. District Court in New Orleans, the executive director of the state Office of Entertainment Industry Development, Chris Stelly, told a state legislative advisory commission that the state should look into more authority over the Certified Public Accountants auditing applications and stricter rules on so-called "related party transactions" in which affiliated companies pay each other for work.

Stelly said the state could hire CPAs performing audits, while the applicants are responsible for the expense. "You eliminate further collusion attempts or anything like that," Stelly told the commission. "We're the client. The applicant continues to pay for the audit, and we get what we want out of the audit."

The biggest challenge, though, is evaluating payments between related companies when calculating for eligible credits, Stelly said. A legitimate example of a related transaction, he said, would be film giant Paramount Picture's grip and lighting subsidiary, The Studios at Paramount, which rents equipment to other major productions as well as its own projects at a fair market value, he said.

Problems arise with transactions among lesser-known companies, when it is difficult to determine whether reported expenses had fair market value, he said.

According to a 2012 audit, in which Seven Arts was pursuing further tax credits, the ownership interests in the 807 Esplanade Ave. project is convoluted and involved payments between several affiliated companies.

The audit says:

The property owner is Seven Arts Pictures Louisiana LLC. That company is 90-percent owned by Hoffman's legally separated wife Susan Hoffman through a company named New Moon Pictures LLC. The remaining 10 percent is owned by 807 Esplanade Ave MT LLC, which is further divided among a bank, Markoff of lender Palm Finance and New Moon Pictures.

$350,000 in "legal and advisory services provided by Mr. Hoffman and Mr. Arata"

$200,000 for "construction finance supervision"

The records were included in a lawsuit filed by Seven Arts Pictures Louisiana against the state Department of Economic Development in August, demanding more tax credits after receiving a rejection. The case in East Baton Rouge Parish was put on hold after the Louisiana Inspector General's Office intervened, pointing to the criminal investigation, according to court records.

Inspector General Stephen Street, whose office helped investigate the charges against Hoffman and Arata, said he couldn't comment on the case specifically.

In general, though, he said fraud in the film tax credit program continues to be an issue, and it is a priority for his office. "It's a priority for us because we're talking millions of dollars," Street said. "This is money that the state can't afford to lose."

"What we've run into is just false submissions, where the documentation that's submitted to the state in order to get these credits certified is either outright fraudulent or incomplete or omitting material facts," he said.

He said the state must make it harder for the people determined to steal.

Moret, the state's economic development chief, said over the past six years, his office has worked to improve administration of the program, including assigning more staff, issuing detailed rules and audit guidelines and bringing on a forensic auditor for more oversight.

In January, he said, his office hosted a day-long seminar on tax credits with the Louisiana Society of Certified Public Accounts. Moret said about 40 CPAs heard from the FBI and the Inspector General's Office about a "zero-tolerance policy for program abuse."

Seven Arts was awarded tax credits "only after receipt of an audited expenditure report by an independent CPA as well as a review by the state's forensic auditor," Moret said.

"Over the last decade, Louisiana's film production industry has experienced unprecedented growth, catalyzed in large part by the state's unique Motion Picture Tax Credit Program," Moret said. "Louisiana has made a major fiscal commitment to cultivating this industry, so it is critical that these tax credits be utilized only for eligible film production or infrastructure expenditures."